'Nest egg' is often self-directed

For millions of you, a "self-directed defined contribution plan" is your principal retirement nest egg. What you collect will depend on how much tax-deferred money you decide to put away every month, the amount your employer decides to contribute -- and how you choose to have your money invested.

Such plans cost your employer less and relieve him or her of some of the burden of making management decisions. That's why the number of workers in defined "contribution" plans is increasing significantly. Retirees in defined "benefit" plans, the traditional pension, receive retirement income funded by their employers and based on salary plus years of service. Defined benefit plans are insured by the federal government. Defined contribution plans are not.

"Defined contribution plans have no fixed payments or federal guarantees," points out Prof. Edward Graves, who teaches insurance principles to chartered life underwriters and chartered financial consultants at The American College in Bryn Mawr, Pa.

Nearly half of all employee pension plans are now the contribution type, up from about 20 percent less than a decade ago. Graves observes that "virtually every new pension plan designed today is based on the contribution model."

Direct contribution retirement portfolios include profit sharing, savings and 401(k), or salary reduction plans. The popular 401 (k)s are funded by pre-tax dollars contributed by the employee and often matched, 50 cents to the dollar, by employers. The money accumulates tax-free until a payout is made.

The investment options you may be offered include stocks (including your own company's), bonds, certificates of deposit, money market funds and guaranteed investment contracts (GICs). Historically, most workers have been highly conservative when asked to make their own investment decisions, favoring safety over yield. The volume of fixed income investments held in self-directed defined contribution plans normally exceeds money invested in stocks by more than two-to-one.

Despite fears triggered by the current bear market, Graves believes equities, with their potential for high returns, should remain a very important part of nearly all pension investment allocations except for individuals nearing retirement.

"Over the long term," he notes, "it's been demonstrated repeatedly that stocks will substantially outperform any other kind of investment. But individuals close to retirement are probably wiser to seek the relative safety of a fixed income vehicle."

Guaranteed investment contracts (GICs) -- usually sold by insurers and sometimes by banks -- continue to be the most popular form of fixed income investment for contribution plans.

A recent survey of 343 companies with 401(k) plans, conducted by the employee benefits consulting firm A. Foster Higgins & Co., found that many employees made multiple choices, with GICs being chosen by 57 percent; other choices were equity funds, company stock, balanced (diversified) funds and money market funds. The average 1989 rate of return for GICs in the survey was 9.39 percent, but 16 percent of the larger plans reported returns of 10.5 percent or more.

The appeal of GICs is not hard to understand, Graves tells his students at The American College. Whenever the contract expires, which can be as little as six months, the issuer guarantees payment of the full principal as well as a very competitive interest rate compared to other low-risk investments, almost always higher than CDs or Treasuries.

On the downside, recent widespread media reports about the insurance industry's substantial junk bond holdings and depressed real estate assets have raised concerns among some employees and employers about GICs. But the giant firms that dominate the GICs market are not facing insolvency, Graves maintains.

Although junk bonds make up only a tiny percentage of all retirement funds, Graves advises employees to check directly with their firm's benefits official or the pension plan administrator. "Ask about the investment portfolio rate of return and the credit rating of the insurers selling GICs to your company," he suggests.

"Be wary of any company guaranteeing rates significantly in excess of its portfolio rate of return. You'll probably also discover that the kind of household-name companies that sell GICs all have top triple A or A-plus ratings -- and that's critical in assessing the health of any insurer."